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High Yield Debt Market Woes: Echoes of 2008?

In the Headlines: brought to you by Adrian Rowles

A day after a prominent Wall Street firm shocked investors by freezing withdrawals from a credit mutual fund, things only got nastier in the junk-bond market. Prices on the high-risk securities sank to levels not seen in six years and, to add to the growing sense of alarm, billionaire investor Carl Icahn said the selloff is only starting. “The meltdown in High Yield is just beginning,” Icahn, who has been betting against the high-yield market, wrote on his Twitter account. Icahn’s comments come as junk-bond investors, already stung by the worst losses since 2008, are the most nervous they have been in three years after Third Avenue Management took the rare step of freezing withdrawals from a $788 million credit mutual fund.

The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, rose 36 basis points to 514.52 basis points, the highest since December 2012. BlackRock’s iShares iBoxx High Yield Corporate Bond ETF, the largest fund of its kind, fell to the lowest levels since 2009.

The move by Third Avenue, announced on December 9th, is the latest omen of stress in a market already beaten down by a prolonged slump in oil prices that has battered the energy sector. The news came as the global appetite for risk is souring with the countdown to the Federal Reserve’s probable interest-rate increase sparking a selloff in equities and other risk assets. “The timing could not be worse,” said Peter Tchir, Head of Macro Strategy with Brean Capital LLC in New York. “Everyone is already nervous about liquidity, oil, the Fed hike—and you get this extreme event on top of it all. There is a lot of confusion. It’s put people on edge.”

Oil declined to the lowest level since 2008, exacerbating losses in high-yield energy debt, which makes up 12% of the broader market. Market woes have seen outflows from U.S. high-yield bond funds running at the fastest pace in more than a year as U.S. junk debt has declined 3.6%, the first annual loss since 2008, according to Bank of America Merrill Lynch Indexes. “Sentiment is heavy,” said Jerome Conner, who helps oversee about $52.9 billion as Portfolio Manager and Senior Investment Analyst at Federated Investors, Inc. Falling oil prices continue to weigh on markets, and “people see the Third Avenue headline and that contributes to the negative sentiment in the market,” he said.

The step Third Avenue took is unusual for a mutual fund, which typically offers daily liquidity to investors, and comes after regulators raised concerns that some mutual funds are investing in assets that could be hard to sell in a market rout. David Barse, Third Avenue’s Chief Executive Officer, said blocking redemptions was necessary to avoid fire sales. The fund, which had $3.5 billion in assets as recently as July of last year, suffered almost $1 billion in redemptions this year through November. The Third Avenue fund lost 13% in the past month and is down 27% this year, according to data compiled by Bloomberg. Assets have declined to $788 million as of December 8th, as clients pulled an estimated $979 million this year through November, according to Morningstar, Inc.

“It’s significantly bad news for the market, and another straw on the camel’s back,” said Martin Fridson, a money manager at Lehmann Livian Fridson Advisors LLC. “It’s not typical, but it raises the question: Can this happen to the next-worst fund? You just don’t know. It certainly doesn’t encourage people to put money in, and that just exacerbates the liquidity problem there.”

The weakness in the market comes as credit quality in speculative-grade debt is falling. For every junk-bond issuer that had its rating boosted this year, two have been downgraded, a ratio not seen since 2009, according to data compiled by Bloomberg. And companies are increasingly defaulting on their debt. Swift Energy Co.’s failure to make an $8.9 million interest payment last week raised the global tally of defaults to 102 issuers, a figure last exceeded in 2009, according to Standard & Poor’s. Bonds of Freeport-McMoRan, Inc. are also plunging. The copper producer’s $2 billion of 3.55% notes due 2022 dropped $02.5 Friday to $0.58 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They yield 13.9%. Notes of mining company Anglo American Capital Plc also slid. Its $650 million of 4.875% notes maturing in 2025 fell $07.25 to $0.60 on the dollar, according to Trace. They yield 12.1%. As worries grow about the high-yield bond market, debt-market liquidity and the impact of cratering oil prices, many in the financial markets wonder if this is a signal of far deeper problems that may soon surface.